State Street Temporarily Stops Cash Redemptions For Muni-Bond ETFs

A flurry of selling in municipal bond ETFs this week prompted one of the market’s largest exchange-traded fund sponsors to temporarily stop redeeming shares for cash. The move underscored how hard-pressed frantic sellers became in the heat of this week’s selloff.

State Street Global Advisors, the asset management arm of State Street Corp., told Wall Street trading desks Thursday that it would only accept so-called “in kind” redemptions for its suite of muni-bond ETFs, according to Tim Coyne, State Street’s global head of SPDR ETF capital markets. A spokeswoman said State Street resumed allowing dealers to its muni ETF shares for cash on Friday.

The move doesn’t directly affect end investors who are selling the ETF shares in the open market; they still get the cash in exchange for their shares as they normally would.

In bouts of strong selling, certain broker-dealers deliver blocks of ETF shares to their issuer, who then retires unwanted shares from the market. In return, dealers generally take ownership of the underlying bonds from State Street, Coyne said. For a fee, dealers can instead take cash from State Street, which then sells the bonds back into the market.

On Thursday, selling bonds became so difficult and expensive that State Street disallowed the option for dealers to take cash. For State Street, the risk was that unloading bonds could eat into investor returns, or cause the ETF’s price to veer from its underlying index, Coyne said.

For dealers, in-kind only redemptions could potentially pinch those forced to take illiquid bonds onto their books.

Coyne said State Street’s portfolio manager alerted dealers of the change, stressing that redemptions were available at all times on an in-kind basis.

“Our priority is to protect the existing shareholders in our product,” Coyne said. “Redemptions were not stopped at all. Our standard procedure worked perfectly,” he said.

Debt issued by states and local governments, like all bonds, has been hit hard in recent weeks amid concerns about rising interest rates. That selloff intensified this week after Federal Reserve Chairman Ben Bernanke echoed that the central bank could pare back its monthly bond-buying efforts should economic conditions improve.

“Once people come in and need their money, even if there’s not a bid, [ETFs] have to sell their bonds. There’s no flexibility,” Timlin said. “In this market, everybody is a seller, and there’s too many people trying to exit at the same time.”

Update:Earlier Mr. Coyne had said State Street hadn’t resumed allowing dealers to swap muni ETF shares for cash on
Friday.